The 1st July 2017 changes have increased tax for wealthy pensioners. Non-commutable legacy pensions such as Sec 1.06(2) lifetime, Sec 1.06(7) life expectancy and Sec 1.06(8) market linked often have quite decent assets backing them. This is because many were set up to access higher Reasonable Benefit Limits. While RBLs are now defunct, there has been no opportunity granted by government to tidy up these legacy products. With the introduction of the $1.6m Transfer Balance Cap limiting the tax exemption which applies to income from assets funding superannuation pensions, special rules had to be put in place for these legacy pensions. The rules can be very harsh and generate a massive tax win-fall for the Government. The purpose of this article is to show that (with careful planning) it is possible to mitigate some of that harshness.
Since “capped defined benefit income streams” can’t remedy a breach of Transfer Balance Cap (TBC) with a commutation, the modifications for these products results in certain amounts being included in personal assessable income or adjustments to tax offsets. Let’s say Bruce – who is aged 72 – has $3.7 million backing a lifetime pension paying him $200,000 in 2017-18 with 4.9% p.a. indexation in subsequent years. The regulations assign a value of 16 times this to be counted against the TBC – an arbitrary (and in many instances totally inappropriate) value. However, ignoring that one can see Bruce is way over the TBC and any Account Based Pensions will have to be commuted. More nasty ramifications creep in on the administration side as it will be necessary to start deducting and remitting PAYG deductions from the lifetime pension payments.
Hopefully, Bruce is not the “shoot the messenger” type of person when told that over the next 15 years (roughly his life expectancy) he will pay about $595,343 in additional tax that he is not currently paying. This is because 50% of the pension payments in excess of $100,000 p.a. (indexed) is added to his personal assessable income. If he is on top marginal tax rate already, that is a lot of extra tax. Saying “tough, you’re rich and can afford it!” may not be the best approach if you want to keep this client. So let’s see what can be done...
We need a strategy that will reduce pension payments that end up in assessable income and slow the rundown of exempt current pension income assets. We don’t have to worry about the retirement income Bruce wants to draw as this can be achieved via tax free withdrawals from an accumulation account in many instances. One way to do this is to convert the 1.06(2) lifetime pension to a 1.06(8) market linked pension with a long duration and utilise the minus 10% drawdown variation that is allowed. The table shows total tax paid personally by both approaches if the marginal tax rate is 47% - this may be higher with the announced Medicare levy changes.
|Year||TBC Income||Lifetime||Assessable||Tax||Market Linked||Assessable||Tax|
This strategy results in tax savings on an undiscounted basis of $404,018. It also allows a higher average Exempt Current Pension Income over the years and a better reserving policy to be set up. One of the issues to be solved with a lifetime pension is monies are expected to be released to “free surplus” reserves when the pensioner passes away.
Estate Planning preferences may cause a different solution to the above. There is a large element of personal preference in setting the optimal strategy. Often an objective will be to avoid paying superannuation death benefit tax to financially independent children. It is simply an inheritance tax by a different name. Individual circumstances can be far more complex than above and each scenario requires careful analysis. There are still a number of issues where the regulator has been silent. One example is Section 1.06(6) flexi pensions. To be prudent, one would imagine that TBC applies and commutation must be in line with Schedule 1B factors. To my knowledge, no material has been published so far by Treasury or the ATO on this aspect.
A far better solution would be to allow these legacy pensions to be commuted back to the $1.6m cap and fix up the “special value” methodology shortcomings. Indeed, I would go a step further and require all these legacy pensions to be converted into a standard Account Based Pension. Our politicians and regulators have done Australia a great disservice by the level of complexity that is now built into superannuation regulation. While we are creating an understandable system for normal citizens, anomalies like different Age Pensions for a person who went on the Age Pension on 19/09/2016 versus 20/09/2016 can be added to the list. In the absence of that simplicity it is important to careful consider how to make the 1st July 2017 Transfer Balance Cap less taxing.
If you have a client that needs an analysis and report, we would be delight to assist. Information needed is the latest accounts, member statements and actuarial report. Cost of the report ( that can be a Para-plan for a full SOA ) is $550 inclusive of GST.